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Wrong Incentives

University of Chicago economist Steven Levitt (of Freakonomics fame) has made a name for himself outside the economics profession by emphasizing the role of incentives in everyday life.

"Economics is, at root, the study of incentives: how people get what they want, or need, especially when other people want or need the same thing. Economists love incentives. They love to dream them up and enact them, study them and tinker with them. The typical economist believes the world has not yet invented a problem that he cannot fix if given a free hand to design the proper incentive scheme... An incentive is a bullet, a lever, a key: an often tiny object with astonishing power to change a situation." (Freakonomics, p. 20)

Levitt's and co-author Stephen Dubner kick off Freakonomics with the extended example of how a new system of "high stakes testing" for grade-school students in the 1990s led about five percent of Chicago public school teachers to alter their students' answers to standardized tests in order to boost scores and earn performance-related raises and promotions.

But how does this kind of pretty run-of-the-mill insight about incentives translate into one of the best selling books of the decade and industry of imitators inside and outside of academia?

The really interesting question is not why a small share of Chicago public school teachers cheated when cheating could raise their pay. The interesting question is why the vast majority of the teachers didn't cheat --especially when getting caught took a University of Chicago professor using a complicated computer algorithm that analyzed "700,000 sets of test answers, and nearly 100 million individual answers" (p. 28) to produced "evidence ... only strong enough to get rid of a dozen of them" (p. 37)?

Elinor Ostrom, who won the most recent Nobel Prize in Economics, spent a large chunk of her professional life looking at exactly the more interesting of these two questions. In particular, she wanted to know why there were so many exceptions to the "tragedy of the commons" --where individuals have an incentive to overuse jointly owned resources such as community grazing land or fishing grounds. Her research on a variety of commonly owned resources in a variety of different national settings showed that communities frequently develop a complex set of formal and informal institutions, from social norms to monitoring and governing structures that blunt the economic incentives and avert the tragedy of the commons.

Early on in Freakonomics, Levitt and Dubner pay lip-service to non-economic incentives, noting that "There are three basic flavors of incentives: economic, social, and moral. Very often a single incentive scheme will include all three varieties." (p. 22) But, the whole book, the whole franchise, is about how economic incentives consistently trump social and moral incentives among sumo wrestlers, real-estate agents, drug dealers, and many others.

Of course, Levitt and Dubner may well be on to something. Levitt has made millions from Freakonomics and is now one of the best known economists in the world. Ostrom, despite decades working on the research that led to her Nobel, was (and will likely remain) almost a complete unknown in the economics profession, not to mention among the general public.